What happened
Shares of GSX Techedu (GSX 1.01%) are rising today. As of 12:00 p.m. EDT, the stock was trading 9% higher. And it's appreciated almost 25% since May 21 -- just a couple days after influential short-seller Muddy Waters revealed a short position in the stock.
Today, another research firm called Grizzly Research announced that it believes most of GSX Techedu's students are fake, consistent with Muddy Waters' report. However, Wall Street is inexplicably shrugging off this news, with shares rising for the session.
So what
On May 18, Muddy Waters said it was short GSX Techedu stock because the company was "a near-total fraud." By analyzing the available data, Muddy Waters found suspicious classroom participation patterns, from which it concluded that at least 73% of users were fake. Given Muddy Waters' reputation of uncovering fraudulent Chinese companies, GSX Techedu stock dropped on the report.
GSX Techedu management soon responded to Muddy Waters' claims. It provided explanations for the suspicious patterns the research firm had noticed. For example, Muddy Waters saw multiple users joining a classroom at the exact same time -- statistically impossible for students joining from diverse locations. However, management said students participate in warm-up exercises and are then transferred to the classroom at the same time when the class starts.
Perhaps that explanation satisfied Wall Street, as the stock rose in recent days. However, today Grizzly Research's sleuthing echoed Muddy Waters' investigation. It believes both student enrollment and revenue are overstated by 900%. If true, that would be devastating for GSX Techedu shareholders.
Notwithstanding this news, GSX Techedu stock is rising today. The company's management has released two statements now in response to Muddy Waters that appear to have satisfied Wall Street. Perhaps investors expect a similar forthcoming response to Grizzly Research. While that could be enough to explain why the stock isn't going down today, there's no positive news or update that explains what is moving shares higher.
Image source: Getty Images.
Now what
Stating the obvious, when research firms accuse the company of fraud, it's material to GSX Techedu shareholders. In a worst-case scenario, the accusations would be substantiated and make the stock a candidate for delisting. That could send it down to penny-stock territory.
It's fair to note GSX Techedu management hasn't been silent, providing investors with explanations for these findings of fraud. So it's the word of one against the other. Both Muddy Waters and Grizzly Research provided instructions for investors wanting to replicate their findings. Given the seriousness of the accusation, it's in investors' best interest to do extra due diligence with GSX Techedu stock -- verify the researched findings and compare to GSX Techedu management's explanations. Those not willing to put forth this extra effort shouldn't consider buying shares, at least until this issue is fully resolved.
